Variable Universal Life Insurance
Variable Universal Life Insurance
Variable Universal Life (VUL) insurance is one of the most flexible life insurance products available today. It is permanent insurance, offering guaranteed lifetime protection while combining the adjustable premiums and coverage of universal life with the growth potential of variable life. However, it’s important to note that guarantees are subject to the claims-paying ability of the insurer. With VUL, you have control over several aspects of the policy, such as when and how much you pay in premiums (within certain limits), the amount of the death benefit, and the way your policy’s funds are invested.
How a Variable Universal Life Policy Works
Unlike other types of life insurance policies, there is no fixed required premium for a VUL policy. Instead, you need to pay enough to cover the insurance company’s expenses and the mortality cost (the cost of pure insurance). Typically, you instruct the insurer to send a premium notice for a planned amount, which you can either pay, skip, or adjust depending on the policy's value at the time.
Each premium payment you make is subject to sales and administrative expenses. The remaining funds are added to a cash value account from which the insurance company deducts its monthly cost for insuring your life. It’s essential to monitor your cash value to ensure that you have enough to cover the costs, or the policy will lapse. If you contribute more than required, the excess amount is invested in separate accounts (sub-accounts), distinct from the insurer’s general account.
The Separate Account
Money in a VUL policy is controlled by the policyholder, unlike the cash value in traditional life insurance policies. Your funds are placed into an account separate from the insurance company’s general account, where you can choose from a variety of sub-accounts. These could include stock funds, bond funds, and money market accounts. You have the flexibility to allocate your money into these sub-accounts without charge, up to certain limits. Because these sub-accounts are securities-based, they offer the potential for higher growth compared to non-variable insurance policies. However, this also comes with greater volatility and the risk of losses. Growth is not guaranteed, and your cash value can fluctuate on a daily basis, so it’s important to monitor performance closely and consult with an investment professional if needed. The cash value of VUL policies is regulated by the Securities and Exchange Commission, and you will receive a prospectus that provides detailed information on investment objectives, risks, and expenses.
Adjustable Death Benefit
One of the main features of a VUL policy is the ability to adjust the death benefit to suit your changing financial needs, according to the insurer’s guidelines. For example, if you pay off your mortgage, your need for insurance might decrease. However, if you wish to increase your coverage, you may need to undergo the underwriting process, including a medical exam. When you purchase the policy, you may have the option to choose between a level or enhanced death benefit, and you can switch between them later.
Level Death Benefit: This option provides a fixed death benefit. If your cash value grows, the amount you pay for insurance decreases by an equal amount. For example, with a $200,000 policy and $50,000 in cash value, you would only pay for $150,000 of pure insurance coverage.
Option 2 (Increasing Death Benefit): In this option, your cash value is added to the death benefit. So, if you have a $200,000 policy and $50,000 in cash value, your beneficiary would receive $250,000. However, you’ll still pay for the full $200,000 coverage, regardless of how high your cash value grows.
Partial Withdrawals and Policy Loans
As with most permanent life insurance, the cash value in a VUL policy can be used as collateral for loans from the insurance company, usually tax-free. Interest is charged on the loan, which could be fixed or fluctuate depending on the terms. If you borrow against your cash value, that portion is transferred to the insurer’s fixed interest account because there is a risk that the balance in the variable sub-accounts could fall below the loan amount due to market fluctuations. Loans will affect the return on your investment in the sub-accounts.
If there is an outstanding loan at the time of your death, the death benefit paid to your beneficiary will be reduced by the loan balance plus accumulated interest. Another option is to make a partial withdrawal (partial surrender), which doesn’t require you to repay any interest. However, it will permanently reduce your death benefit, and depending on the situation, could trigger a taxable event.
Sales Charges and Other Fees
Most VUL policies impose a sales charge on each premium payment. These charges are typically not sufficient to cover the full costs of acquiring the policy, so the insurance company recovers these costs over time from the policy’s profits. If you surrender the policy before the insurance company has recovered these costs, a surrender charge will be applied to the cash value. Additionally, the fund managers of your sub-accounts will charge fees similar to mutual fund fees.